Search form

The Euro Isn’t Dead (Yet)

People have been forecasting the end of the euro since the
currency came into being in the late 1990s. Yet the euro has
survived five sovereign bailouts—including three successive
ones of Greece (the continent’s most troubled
economy)—and two bank rescues aimed at Spanish and Cypriot
banks. The Eurozone debt crisis reached a climax in the summer of
2012, when European Central Bank Chairman Mario Draghi defused it
with his vow to do “whatever it takes” to preserve the
single currency.

Regardless of one’s views on the prudence of the
ECB’s subsequent monetary easing, Draghi’s promise
succeeded in calming financial markets.

Yet six years on, political uncertainty in Italy and Spain has
people pondering the imminent demise of the euro again:

To many southern
Europeans, euro membership is the lesser of two evils when greater
monetary control by their national governments is the
alternative.

Earlier this week, the Italian president’s refusal to appoint a finance minister who had
previously advocated contingency planning for a
potential Italian exit from the euro unsettled bond markets,
causing interest rates on the country’s debt to skyrocket. While
subsequent negotiations have ended the stalemate and delivered a coalition
government, their members’ strong anti-EU disposition will prolong
policy uncertainty.

In Spain, a vote of no confidence in the centre-right
government has led to its replacement by a left-wing administration
propped up by communists and separatists, igniting fears that the
market reforms undertaken since 2012 may be unraveled.

And raising taxes, increasing regulation and centralizing power
would indeed spell doom for the Spanish economy, whose GDP has been
growing at annual rates in excess of 3 percent for three years.
Unemployment, which topped 26 percent at the height of the crisis,
has since fallen rapidly thanks to a much-needed loosening of
hiring and firing rules.

Italy’s recovery has been less resplendent, with tepid growth,
stagnant labor productivity and wages, and a national debt of
around 130 percent of GDP. Nevertheless, its fiscal position had
stabilized in recent quarters and business investment had picked up
after a number of modest regulatory reforms.

* * *

Skeptics of the euro blame the single currency for the poor
economic outcomes of southern European countries (the uncharitably
nicknamed “PIGS”).

However, if you look closely at the data, it’s clear that
bad performance long precedes the advent of the euro: Unemployment
rates of 25 percent have characterized every major Spanish
recession since the 1970s. Greece has defaulted on its external
debt on half a dozen occasions since it became an
independent country. Italian productivity growth began to falter in
the early 1990s, hampered by onerous labor market rules,
inefficient taxation, poor property rights protections, and a weak
bankruptcy code.

In other words, the barriers to the economic healing of these
countries lie mostly with domestic politics and policy, not the
strictures of their membership in the Europe-wide currency.

There are problems with the euro, to be sure. A single currency
for a large and diverse geographic area makes optimal monetary
policy difficult to implement. Furthermore, the absence of control
over the currency makes governments unable to use devaluation as
tool of crisis management. (Although depreciating currencies can
temporarily improve a country’s competitive position, in the
long-run it lowers living standards and has historically been
resorted to more by incompetent governments in failing economies
than by responsible democracies.)

Another problem of the euro as it exists today is that its rules
are routinely violated. Member countries were never supposed to
borrow as much as many have. Nor was there supposed to be any
tolerance for bailing out individual countries. Some have even
questioned the constitutional propriety of the ECB’s monetary
loosening.

But, to many southern Europeans, euro membership is the lesser
of two evils when greater monetary control by their national
governments is the alternative. There are few things that Spaniards
and Italians enjoy less than the patronizing politicians from
Germany and the Netherlands. But one of them is surely their own
political classes.

Which explains the persistence of public support for euro membership, even as
politicians routinely disparage the constraints it places on
domestic policy-making. When the Greek government held a referendum
on the conditions imposed by its creditors in 2015, a majority
supported its defiant stance. Yet Greeks refused to countenance the
country’s departure from the euro and the E.U., and the associated
loss of freedoms and purchasing power.

This time is unlikely to be any different. Even if political
squabbles prolong uncertainty into the summer, the cataclysm will
probably fail to materialize. There is simply too much at stake in
Italian and Spanish membership of the euro, and even disgruntled
citizens know this in their heart of hearts.